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NEW YORK — Wall Street lost more ground in extremely volatile trading Monday, as investors recoiled at a cautious economic outlook from a Federal Reserve official and the possibility of more financial troubles of Fannie Mae and Freddie Mac.

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The market found only slight solace in retreating oil prices.

San Francisco Federal Reserve President Janet Yellen said in a speech the financial markets remained fragile, and that it will take time for conditions to improve. “My expectation is that market functioning will improve markedly by 2009,” she said. “But things could get worse before they get better.”

The comments added to concerns raised in a note by Lehman Brothers analysts that Fannie and Freddie may need to raise more capital as the credit crisis continues. Worries about the ailing financial sector deflated a stock rally early in the day that had been fueled by a $4-a-barrel pullback in oil prices.

The market managed, however, to rebound from its lows of the day, when the Dow Jones industrial average sank to its worst level since mid-August of 2006. Some investors bought back into the market to take advantage of the low prices.

“The market is so skittish and so scared that half the people believe that this is just another leg of the down market and the other half believes that we’re forming a bottom,” said Frank Ingarra, assistant portfolio manager at Hennessy Funds.

The Dow fell 56.58, or 0.50 percent, to 11,231.96. Over the course of the day, the blue chips rallied, tumbled, rebounded, and then fell once more. The Dow fell as much as 167.80 to 11,120.74 — its lowest trading level since Aug. 15, 2006 — but was also up more than 100 in early trading.

The technology-dominated Nasdaq got a modest boost from Yahoo Inc., which rose $2.56, or 12 percent, to $23.91 after Microsoft Corp. expressed support for investor Carl Icahn’s effort to oust Yahoo’s board next month. Microsoft said a successful rebellion would encourage it to renew its takeover bid for Yahoo, or negotiate another deal.

Light, sweet crude fell $3.92 to close at $141.37 a barrel on the New York Mercantile Exchange, after falling by more than $5 a barrel at times.

The retreat did little to assuage fears about high energy prices, however. Wall Street, which has been hurtling stocks lower for the past few weeks, remains fearful that consumers are trimming their spending to pay for gasoline. With consumer spending accounting for more than two-thirds of U.S. economic activity, a pullback could create big ripples.

Volatility on Wall Street, as measured by the Chicago Board Options Exchange’s volatility index, on Monday briefly hit its highest point since March, when worries about the financial markets peaked during the buyout of Bear Stearns Cos.

“It indicates that there was more fear entering the market than there had been in previous weeks,” said Todd Salamone, director of trading and vice president of research at Schaeffer’s Investment Research.

Fannie Mae fell $3.04, or 16.2 percent, to $15.74 and Freddie Mac fell $2.59, or 17.9 percent, to $11.91, after Lehman Brothers analysts said new accounting rules could require Fannie to raise $46 billion more capital and Freddie to raise $29 billion.

Citigroup Inc., JPMorgan Chase & Co., and Bank of America Corp. also saw their shares fall ahead of their earnings reports later this month. Citi fell 42 cents, or 2.5 percent, to $16.40; JPMorgan dropped $1.27, or 3.6 percent, to $34.04; and Bank of America fell 87 cents, or 3.9 percent to $21.53.

In addition to financials, Merck & Co. dragged on the Dow, falling $1.85, or 4.8 percent, to $36.60. A UBS analyst downgraded the drug maker, citing slowing sales of its HPV treatment Gardasil.

Meanwhile, General Motors Corp. is considering cutting more white-collar jobs and getting rid of some brands, according to a person familiar the company’s discussions. The person asked not to be identified because no decisions have been made. GM shares, which recently sank to all-time lows, rose 12 cents to $10.24.

Investors haven’t been as optimistic lately about the prospects for an economic recovery in the second half of 2008 as they once were. The Dow has fallen the last three weeks while the S&P 500 index and the Nasdaq have logged five straight weeks of declines. With drops of more than 20 percent from their October highs, the Dow and the S&P 500 entered bear market territory last week as rising oil stirred inflation concerns.

Scott Fullman, director of derivatives investment strategy for WJB Capital Group in New York, said some negative technical indicators on Thursday presaged the market’s weakness Monday. Notably, there were no companies that set 52-week highs on the New York Stock Exchange on Thursday, Fullman said. “It’s unusual to see a drop-off like that.”